US companies face trillion-dollar cash headache

Jonathan Shapiro

eBay is one US company that decided to bring its foreign cash haul home. Photo: AP

A mind-blowing $US1 trillion ($1.07 trillion) of United States corporate cash lies trapped in foreign countries.

How to free it, put it to use or repay agitated shareholders, while avoiding the billions of dollars of taxes owed to the US government, is now a major headache for management and a top priority for boards.

First some background as to how $US1 trillion of US corporate cash, or around 60 per cent of the entire total US cash balance, has become stuck in tax-friendly jurisdictions like Ireland.

To take advantage of materially lower tax rates – Ireland's corporate tax rate is one third of that in the US – America's largest companies legally restructured their companies so the Intellectual Property, and therefore, the profits, flow to places with the lowest tax.

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Cutting the tax bill by such a significant amount seemed like the right thing to do by shareholders, but it has become a major problem because the elaborate paper shuffle to cut taxes may be destroying rather than creating value for shareholders.

The problem is that ultimately this foreign cash will need repatriation, either to pay US expenses or to be returned to shareholders in the form of dividends or share-buy backs.

When that day comes, Uncle Sam will get his 35 per cent of the profits.

The way most companies avoid repatriating tax is to borrow against the offshore cash in the bond markets.

Apple for instance has more than $US160 billion of cash but has issued almost $US30 billion of debt in the past two years to pay dividends or buy back shares without having to bring its cash home.

The solution is costly. Corporate borrowing costs may be at historical lows but cash pays zero, so companies and their shareholders suffer from "negative carry" and an erosion of wealth in order to have their cash returned.

Borrowing against the cash is the most popular solution to the trapped cash problem. Another is to simply bite the bullet and pay the tax. The first company to flinch was eBay, which last month brought back its $US9 billion of cash, of which almost $US2.8 billion was paid in US taxes.

The rationale is that eBay now has the onshore firepower to pursue deals and is no longer subjected to the negative carry should it need the cash. Another argument is the market isn't really assigning full value to the trapped cash so it was better to "realise" it.

Finally, the most creative solution is to "follow the money". Some US companies, particularly in the cash rich health-care sector are effectively relocating, via acquisition, to where the cash is based.

Several deals have been completed in the pharmaceutical industry, which has a total non-US cash balance of $US232 billion, whereby an acquisition has allowed a company to be effectively become re-domiciled so it can free the trapped cash at a lower tax rate.

"Tax inversion" as it is known in the industry has been pursued aggressively and was the sole driver of Pfizer's recent $118 billion tilt for European peer AstraZeneca. Pfizer's $US 48 billion cash pile is the fifth largest in the US.

Tax inversion is very controversial as is the whole issue around corporate cash and foreign tax arbitrage.

While some US politicians are seeking to crack down in mergers that could allow US companies to release their cash, others are contemplating "tax-holidays" that would allow the repatriation of corporate cash (which occurred a decade ago in the form of the Homeland Investment Act).

With such divergent political views, little is expected to change.

That means this force that is distorting the allocation of capital and valuations in both short-term cash and long-term corporate debt markets is here to stay.